Alexander W. Richter

Income Inequality and Current Account Imbalances

This paper studies the empirical and theoretical link between increases in income inequality and increases in current account deficits. Cross-sectional econometric evidence shows that higher top income shares, and also financial liberalization, which is a common policy response to increases in income inequality, are associated with substantially larger external deficits. To study this mechanism we develop a DSGE model that features workers whose income share declines at the expense of investors. Loans to workers from domestic and foreign investors support aggregate demand and result in current account deficits. Financial liberalization helps workers smooth consumption, but at the cost of higher household debt and larger current account deficits. In emerging markets, workers cannot borrow from investors, who instead deploy their surplus funds abroad, leading to current account surpluses instead of deficits.

The Zero Lower Bound, the Dual Mandate, and Unconventional Dynamics

This paper examines monetary policy when it is constrained by the zero lower bound (ZLB) on the nominal interest rate. Our analysis uses a nonlinear New Keynesian model with technology and discount factor shocks. Specifically, we investigate why technology shocks may have unconventional effects at the ZLB, what factors affect the likelihood of hitting the ZLB, and the implications of alternative monetary policy rules. We initially focus on a New Keynesian model without capital (Model 1) and then study that model with capital (Model 2). The advantage of including capital is that it introduces another mechanism for intertemporal substitution that strengthens the expectational effects of the ZLB. Four main findings emerge: (1) In Model 1, the choice of output target in the Taylor rule may reverse the effects of technology shocks when the ZLB binds; (2) When the central bank targets steady-state output in Model 2, a positive technology shock at the ZLB leads to more pronounced unconventional dynamics than in Model 1; (3) The presence of capital changes the qualitative effects of demand shocks and alters the impact of a monetary policy rule that emphasizes output stability; and (4) In Model 1, the constrained linear solution is a decent approximation of the nonlinear solution, but meaningful differences exist between the solutions in Model 2.

The Zero Lower Bound: Frequency, Duration, and Numerical Convergence

When monetary policy faces a zero lower bound (ZLB) constraint on the nominal interest rate, a minimum state variable (MSV) solution may not exist even if the Taylor principle holds when the ZLB does not bind. This paper shows there is a clear tradeoff between the expected frequency and average duration of ZLB events along the boundary of the convergence region---the region of the parameter space where our policy function iteration algorithm converges to an MSV solution. We show this tradeoff with two alternative stochastic processes: one where monetary policy follows a 2-state Markov chain, which exogenously governs whether the ZLB binds, and the other where ZLB events are endogenous due to discount factor or technology shocks. We also show that small changes in the parameters of the stochastic processes cause meaningful differences in the decision rules and where the ZLB binds in the state space.

Finite lifetimes, long-term debt and the fiscal limit

The U.S. faces exponentially rising entitlement obligations. I introduce a fiscal limit - a point where higher taxes are no longer a feasible financing mechanism - into a Perpetual Youth model to assess how intergenerational redistributions of wealth and the maturity of government debt impact the consequences of explosive government transfers. Intergenerational transfers of wealth strengthen the expectational effects of the fiscal limit and magnify the likelihood of stagflation. A longer average maturity of debt weakens these effects in the short/medium-runs but still increases stagflation in the long-run. Delaying reform increases the severity and duration of the stagflationary period.The U.S. faces exponentially rising entitlement obligations. I introduce a fiscal limit—a point where higher taxes are no longer a feasible financing mechanism—into a Perpetual Youth model to examine how intergenerational redistributions of wealth, the average duration of government debt, and entitlement reform impact the consequences of explosive government transfers. Three key findings emerge: (1) Growing government transfers cause more severe and more persistent stagflation than in representative agent models that do not capture intergenerational transfers of wealth; (2) A longer average duration of government debt pushes the financing of government liabilities into the future and reduces the short-run impacts of explosive transfers; (3) The time it takes the economy to rebound from a period of growing transfers increases exponentially with the number of years it takes to pass entitlement reform.

FORWARD GUIDANCE AND THE STATE OF THE ECONOMY: FORWARD GUIDANCE

This paper analyzes forward guidance in a nonlinear model with a zero lower bound (ZLB) on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule, which capture innovations in expectations from central bank communication about future policy rates. Whereas most studies use quasi‐linear models that disregard the expectational effects of hitting the ZLB, we show how the effectiveness of forward guidance nonlinearly depends on the state of the economy, the speed of the recovery, the degree of uncertainty, the policy shock size, and the forward guidance horizon when households account for the ZLB.

The Consequences of an Unknown Debt Target

Several proposals to reduce U.S. debt reveal large differences in their targets. We examine how an unknown debt target affects economic activity using a real business cycle model in which Bayesian households learn about a state-dependent debt target in an endogenous tax rule. Recent papers use stochastic volatility shocks to study fiscal uncertainty. In our setup, the fiscal rule is time-varying due to unknown changes in the debt target. Households infer the current debt target from a noisy tax rule and jointly estimate the transition probabilities. Three key findings emerge from our analysis: (1) limited information about the debt target amplifies the effect of tax shocks through changes in expected tax rates; (2) the welfare losses are an order of magnitude larger when both the debt target state and transition matrix are unknown than when only the debt target state is unknown to households; (3) an unknown debt target likely reduced the stimulative effect of the ARRA and uncertainty about the sunset provision in the Bush tax cuts may have slowed the recovery and led to welfare losses.

Are Nonlinear Methods Necessary at the Zero Lower Bound

This paper examines the importance of the zero lower bound (ZLB) constraint on the nominal interest rate by estimating three variants of a small-scale New Keynesian model: (1) a nonlinear model with an occassionally binding ZLB constraint; (2) a constrained linear model, which imposes the constraint in the filter but not the solution; and (3) an unconstrained linear model, which never imposes the constraint. The posterior distributions are similar, but important differences arise in their predictions at the ZLB. The nonlinear model fits the data better at the ZLB and primarily attributes the ZLB to a reduction in household demand due to discount factor shocks. In the linear models, the ZLB is due to large contractionary monetary policy shocks, which is at odds with the Fed’s expansionary policy during the Great Recession. Posterior predictive analysis shows the nonlinear model is partially able to account for the increase in output volatility and the negative skewness in output and inflation that occurred during the ZLB period, whereas the linear models predict almost no changes in those statistics. We also compare the results from our nonlinear model to the quasi-linear solution based on OccBin. The quasi-linear model fits the data better than the linear models, but it still generate too little volatility at the ZLB and predicts that a large policy shock caused the ZLB to bind in 2008Q4.

Valuation Risk Revalued

This paper shows the recent success of valuation risk (time-preference shocks in Epstein- Zin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. In a Bansal-Yaron long-run risk model, our revised valuation risk specification that satisfies the restriction provides a superior empirical fit. The results also show that valuation risk no longer has a major role in matching the mean equity premium and risk-free rate but is crucial for matching the volatility and autocorrelation of the risk-free rate.